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China is not one thing
Trip report - July 2024
Having experienced the grinding decline of Chinese share prices, we set off for Shanghai in July with mixed feelings. We were concerned by what the headlines might mean for our companies but excited by the opportunities that irrational fears may create for us as investors.
We are very aware of the mounting risks to China’s economy, but what is true for a whole economy doesn’t always hold true for individual companies. Our investment philosophy focuses on the individuality of each business we invest in, and on our trip to China we spent time with companies to understand how, if at all, their long-term growth potential has been affected by the nation's challenges. We also sought out high-quality businesses whose share prices had been unfairly impacted by the overall negative sentiment towards China.
Market leaders
We met Yiheda Automation, a distributor of factory automation components. Their products and services help increase energy efficiency, equipment longevity and reliability, and are essential for sustainable industrialisation, manufacturing, transportation and energy. Their link to Chinese manufacturing had led the share price to fall over 75% from its peak in August 2021 to a trough in February 20241. This is despite their revenues growing around 45% in US dollars over the same period. Contrary to the prevailing gloom, our visit to Yiheda's offices in Dongguan revealed a sense of excitement. They have recently emerged as the leading provider in China and are enthusiastic about the opportunity to consolidate a growing market dominated by sole traders.
Many companies in China have had a tough couple of years so we have focused our energy on separating cyclical struggles from long-term fundamental issues. With our decade-long time horizon, we are comfortable backing companies through business cycles. Difficult times are inevitable, and we believe the highest-quality businesses have the resilience to emerge from these periods in a stronger position. We met with Midea, the largest home appliance business in China2. Despite the gathering dark clouds, companies like Midea have continued to invest in automation and building technology and strategically position themselves for growth, regardless of the uncertainty ahead.
Construction sector struggles
However, just as CD (compact disc) manufacturers never bounced back from the rise of online music streaming, investors in businesses facing deep-rooted issues are not helped by a long-time horizon. One sector facing structural declines is the Chinese construction industry. China used more cement in 2019 and 2020 than the United States did over the course of the 20th century, it will almost certainly never return to its peak3.
Many companies have been particularly hard hit by the industry’s decline. One example is Oriental Yuhong, the largest manufacturer of construction waterproofing materials in China4. Despite offering high-quality products and holding a leading market share, their sales to property developers have plummeted and many of their customers have begun defaulting on their bill payments.
Benefitting from the turmoil
For other companies, the long-term opportunity may have improved in the geopolitical turmoil of recent years. Centre Testing International, one of China’s largest domestically-based testing and verification company, has benefitted from local companies’ hesitance to contract with foreign suppliers5. The company operates c.160 laboratories and more than 260 service networks in >90 cities worldwide6. Similarly, Inovance, an engineering company focused on high-tech products that enable industrial automation, robotics, electric transportation and renewable energy, has seen its industrial robots rapidly replace their foreign counterparts in recent years.
Individual company opportunities always exist
Trips like this reinforce our belief in assessing each company on its own merits. China is not one monolithic thing and nor are businesses that operate there. It is possible for the overall economy to face challenges while certain sectors and companies thrive. Rather than making sweeping predictions about China’s economy, we focus on identifying well-managed businesses poised to strengthen over the next decade. We remain mindful of the increasing macroeconomic risks but are also excited by the opportunities that widespread fear presents.
Tyler Thomas
July 2024
References to specific securities (if any) are included for the purpose of illustration only and should not be construed as a recommendation to buy or sell the same. Any securities referenced may or may not form part of the holdings of First Sentier Investors' portfolios at a certain point in time, and the holdings may change over time.
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